A regional restaurant chain,Club Café,is considering purchasing a smaller chain,Sally's Sandwiches,which is currently financed using 20% debt at a cost of 8%.Club Café's analysts project that the merger will result in incremental free cash flows and interest tax savings of $2 million in Year 1,$4 million in Year 2,$5 million in Year 3,and $117 million in Year 4.(The Year 4 cash flow includes a horizon value of $107 million.)The acquisition would be made immediately,if it is to be undertaken.Sally's pre-merger beta is 2.0,and its post-merger tax rate would be 34%.The risk-free rate is 8%,and the market risk premium is 4%.What is the appropriate rate for use in discounting the free cash flows and the interest tax savings?

Question

Quizplus · Accepted Answer

r_sL = 8% + 2.0(4%)= 16%; r_sU = 0.20(8%)+ 0.80(16%)= 14.4%.

A Regional Restaurant Chain,Club Café,is Considering Purchasing a Smaller Chain,Sally's